Article

Note: Pursuant to its agreement with KFS Aviation Co. (Lessor/Beneficiary) for the lease and maintenance of several aircraft, Air Philippines (Lessee/Applicant) obtained a transferable standby letter of credit for US$1.5 million from Allied Bank (Issuer). The LC was expressly made subject to UCP500. Lessor/Beneficiary later "transferred" its interest in the LC in favor of London Forfaiting (Transferee).

Lessor/Beneficiary did not fulfill the terms of the lease agreement, providing fewer aircraft than the terms of the agreement stipulated and those aircraft were proved to belong to another party and not to Lessor/Beneficiary. Accordingly, Lessee/Applicant terminated the lease agreement and instructed Issuer not to pay on the remaining balance of the LC. Lessor/Beneficiary informed Lessee/Applicant that it too was terminating the lease agreement.

Lessee/Applicant then sued Lessor/Beneficiary, Issuer, and Transferee to terminate the lease and the LC and to enjoin honor. Both Issuer and Assignee filed Motions to Dismiss, asserting that because the LC was subject to UCP500, it was completely independent of the underlying lease agreement and should not terminate. The Regional Trial Court, Branch 13, City of Manila, took judicial notice of UCP500 and dismissed the complaints against Issuer and Transferee.

Lessee/Applicant appealed from that decision, arguing that the court should not have taken judicial notice of UCP500 because it "does not constitute a matter of public knowledge." Lessee/Applicant also contended that it was deprived of due process by the court's dismissal. On appeal, the Court of Appeals, Ninth Division, Garcia, J., dismissed the appeal.

The appellate court noted that because the LC was expressly made subject to UCP500, it was proper for the trial court to take judicial notice of it. It also noted that Philippine LCs had long been governed by UCP500 provisions, and that its application had been accepted by the Supreme Court in several cases.

The appellate court quoted UCP500 Article 3 which states, in part: "Credits, by their nature, are separate transactions from the sales or other contract(s) on which they may be based and banks are in no way concerned with or bound by such contract(s), even if any reference whatsoever to such contract(s) is included in the Credit." It ruled that pursuant to UCP500 Article 3, the termination of the underlying leasing contract between Lessor/ Beneficiary and Lessee/Applicant had no bearing on the LC obligation.

Comment:

1. While the decision is correct in its deference to the UCP as a set of rules of practice governing letters of credit, it fails to recognize limitations in the doctrine of independence that may be applicable.

2. While the doctrine of independence is globally recognized, so is the exception for Letter of Credit Fraud. The utter failure of the lessor to deliver promised equipment and misrepresentations about them, if proven, would be a candidate for the LC Fraud exception. The court fails to address this possibility and the attorneys for the applicant appear to have spent their energies on the fruitless almost Quixotic attempt to dislodge the UCP from the court's attention instead of addressing the impact of LC Fraud. In addition to the general question of whether the conduct of the beneficiary constituted LC Fraud, it is also relevant what recitals were required in a drawing statement. If they required a reference to a performance under the lease, there may also be a fraudulent statement.

3. Even if there were LC Fraud, there is an additional issue that is rendered obscure by the opinion. It speaks of a transfer of the LC to London Forfaiting in its recital of the facts (beneficiary "transferred its interest in the letter of credit in favor of [Transferee]") but subsequently it appears that London Forfaiting refers to itself as "assignee". The question thus arises whether or not the standby was transferable and transferred in the sense of a transfer of drawing rights. If the standby was transferable in this sense and if it was transferred, then the independence doctrine should operate to shield the transferee beneficiary from any LC Fraud committed by the first beneficiary, even were such fraud proven. The only basis for an exception to the independence principle where there is a due transfer of the credit would result from the conduct of the transferee beneficiary.

4. On the other hand, if the standby was not transferable or if there were no due transfer but only an assignment of proceeds, then the assignee would stand in the shoes of the beneficiary. If it had committed LC Fraud, that fraud would defeat the ability of the assignee of proceeds to recover.

5. In addition, the required statements would also be relevant even if there were a transfer of drawing rights. If the standby was clean, requiring only a demand, the transferee beneficiary would be able to make such a demand. If it required statements about performance under the lease, problems may arise which might not give rise to LC Fraud but which may give rise to a post honor action for making false assertions in drawing on the standby.

[JEB/meg]

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